Read original post

The Possibility of Deflation

In the short term, the U.S. economy could experience a brief period of deflation, which might stem from a severe external shock. However, this scenario is considered unlikely due to the existing fiscal framework and the U.S. status as a reserve currency issuer.

U.S. Debt and Deficit Concerns

The United States' debt-to-GDP ratio stands at 120%, coupled with a deficit of 7 to 8% of GDP. With unemployment rates hovering around 3%, and a net international investment position at negative 65%, these factors create a concerning fiscal landscape. This situation is compounded by the $13 trillion in U.S. dollar-denominated debt held by foreign entities.

Treasury Market Dysfunction Risks

Should deflation occur and not be immediately countered with increased dollar liquidity, the U.S. could face Treasury market dysfunctions, potentially leading to auction failures. Historical precedence suggests that the Federal Reserve and Treasury would intervene to prevent such outcomes, as they have during past instances of market stress in September 2019, March 2020, and several occasions in 2022 and 2023.

Currency Debasement and Asset Values

In the event of deflation, assets that typically benefit from currency debasement, such as stocks, real estate, bitcoin, and gold, would likely retain value. These assets could perform well even if the Fed and Treasury allowed a Treasury auction to fail, which remains a highly hypothetical scenario.

The Need for Dollar Liquidity

The current fiscal situation, characterized by true interest expenses consuming all tax receipts, indicates an urgent need for additional dollar liquidity. Without intervention, the U.S. could revert to a regime where the dollar strengthens while other asset classes decline, a pattern observed in the third quarter of 2023.

Fiscal Dominance and Market Dynamics

Market behaviors suggest a shift towards fiscal dominance, where Treasury market functioning takes precedence over traditional Federal Reserve mandates concerning employment and inflation. This shift is evident in the performance of debasement trades and asset pairings like GLD over TLT, bitcoin over TLT, and S&P 500 over TLT.

Interest Payments and National Defense Spending

Interest payments on U.S. debt now exceed national defense spending, with gross interest spending reported by the Treasury Borrowing Advisory Committee surpassing other significant budget items. As of early 2023, the 'big three' expenditures (entitlements, defense, and interest) amount to 125% of tax receipts, up from 89% in the second quarter of 2016.

Policy Implications and Investment Strategy

The U.S. government's fiscal position suggests that without a productivity miracle or politically unfeasible spending cuts, the only viable solution is to add more dollar liquidity, possibly through rate cuts or currency devaluation. This informs a macroeconomic view that favors positions in gold, bitcoin, and short-term treasuries, all held without leverage. This strategy accounts for the expected continued volatility in global rates, currencies, and risk assets.

Inflation and Interest Payments

Inflationary pressures may increase as the U.S. fiscal situation compels the Fed and Treasury to intervene in the Treasury market to maintain its functionality. The repo rate spike in September 2019 exemplifies this dynamic, marking a point where fiscal circumstances began to significantly influence inflation trends.

In conclusion, the U.S. fiscal situation, characterized by high debt and deficit levels, poses significant risks to the treasury market and broader economic stability. The Federal Reserve and Treasury are expected to intervene as necessary to prevent dysfunction, potentially leading to increased dollar liquidity and inflationary pressures. This landscape informs investment strategies that emphasize assets likely to benefit from currency debasement and accounts for heightened volatility in financial markets.

Read original post

Will we ever get durable deflation again? Or will grandma keep getting sucker punched at the check-out lane. Forever.

Last week I joined Kevin Paffrath -- MeetKevin on Youtube -- for a wide-ranging interview about the economy and freedom.

During our chat, he asked about an ongoing beef between George Gammon and Cathie Wood about whether massive deflation is on the horizon.

The short answer is no: We will never again see durable deflation. Not until either the dollar dies or the Fed dies -- whichever comes first.

The Tech-Led Deflation Debate

Now, if you don't know George and Cathie, he makes financial videos on Youtube, and she's the CEO of Ark Invest, which manages roughly $7 billion and focuses on disruptive high-tech plays like AI, robots, and biotech.

A couple months ago Cathie gave a talk saying that investors were worried about the wrong thing. That we should actually be preparing for massive deflation.

Her reasoning is that technology is inherent deflationary, and we're about to have an epic tech boom.

Visit our Lead Sponsor, Unchained. Protect Your Bitcoin, Reduce your Taxes Coupon Code PETER for $100 off a Bitcoin IRA.

So is she right? Are we about to see plunging prices thanks to AI?

In short, no. Not because her reasoning is off -- she's 100% right that tech is deflationary because it lower prices.

But the missing part is the central bank -- the Federal Reserve. It soaks it all up.

To lay out the process, let's say you make hand-made mugs -- 10 a day. And you sell them for $20 to make ends meet. Now you install a machine and you can make 100 a day. Pay for the machine and you can charge, say, $10 and still turn a profit. Presto, a dollar buys more mugs.

Do that across an entire economy and you get generalized deflation -- dollars buys more.

Indeed, before central banking this was the normal state of a healthy economy -- technology advanced, capital -- machines -- were installed, and we got more stuff for the dollar.

The problem, of course, is that central banks are founded specifically to soak up all that deflationary goodness. In fact, they steal it and then some, turning deflation into inflation.

Enter for free chance to win 50 American Silver Eagle coins — valued at over $1,500! Rated Top Precious Metal dealer by Investopedia.

"Bad” Deflation — the Kind the Fed Makes

Now, there is a special type of deflation which is bad, which is when the dollar is getting stronger not because we make more stuff, but because a bunch of dollars suddenly disappeared. More specifically, they got pulled out of circulation and stored somewhere.

Why would that happen? It could happen because there's World War 3 and everybody panicked. Or, more often, because the Fed crashed the banking system, a bunch of debt evaporated -- it defaulted and got written off.

At which point everybody's scrambling to save dollars to plug their balance sheets. They're not spending the dollars, they're storing them away. As if they buried them in the ground.

Meaning those non-circulating dollars are, at least temporarily, out of the inflation game.

That's exactly what happened in 2008, it's what happened in 1929, it's what happens every financial panic.

In fact, that special case is precisely the excuse the Fed uses to steal the normal, good deflation. It's pretty cute, really -- using the special bank panic deflation the Fed itself causes to steal tens of trillions of healthy deflation year in, year out.

Conclusion

In short, there is zero change we'll have durable deflation. Because the Fed will soak it up and then some. In fact, China's doing this as we speak, printing hand over fist to soak up its over-capacity-driven deflation.

That means whatever deflation windfall one expects from AI, robots, nanoassembly or cold fusion will end up, like so much else, in the pockets of Congress. We will never again see durable deflation.

I'll be speaking at the Restore Freedom Rally, February 2 to 5 in beautiful Orlando, on the coming Tidal Wave of Taxes: What's driving it. Who they'll go after first. And why they won't quit.

There’ll be great speakers every single day, and you can get tickets at Restore Freedom Rally. Use promo code PJ10 to get 10% off.

I hope to see you there!

Sign up for my free newsletter to get weekly articles on the economy and freedom.

Also check out the weekly podcast rounding up all the week’s videos in a single 20 minute podcast.